1. Field of the Invention
The invention generally relates to a method and system for generating an Index-type benchmark for a mortgage-backed securities (MBS) sector of the securities market.
2. Description of the Related Art
In the stock market, an index is a device that measures changes in the prices of a basket of shares, and represents the changes using a single Fig. The purpose is to give investors an easy way to see the general direction of shares in the index. The FTSE 100 Index, for example, is calculated by taking a weighted average of the share prices of the largest 100 companies on the London Stock Exchange. Launched in 1984 with a base Fig. of 1,000, the FTSE is calculated continuously throughout the trading day.
Generally speaking, an index is defined by a pre-determined universe of individual issues valued or weighted in proportion to their size within the whole universe of issues. The Standard & Poor's 500 Index is an example of such an index and is based on the common stocks of the 500 largest corporations which trade on United States exchanges. Illustratively, the weighting for each different security in the S & P 500 index is simply the market capitalization of that security expressed as a percentage of the total market capitalization taken across all the securities then in the index. Of course, these weights continually change as share prices move which, in turn, changes market capitalization both of each individual security in the index as well as that across the entire index. Other indices, such as the Value Line index, assign their own, e.g. equal, weightings to each security therein.
Capitalization weighting is the most common approach to equity indices and equity portfolios. Cap-weighted portfolios are easy to maintain because the rebalancing process takes care of itself. An algorithm for rebalancing a capitalization weighted stock index is disclosed, for example, in U.S. Pat. No. 6,061,663 (the '663 patent). The '663 patent teaches a method and system for rebalancing an equity portfolio based on weighting characteristics of individual securities. Similar to other known equity indices, e.g. S&P 500 Index, in the '663 patent the weighting characteristic of a particular security is based on the market capitalization of that security expressed as a percentage of the total market capitalization taken across all the securities then in the index. The computer program disclosed in the '663 patent includes instructions to classify stocks in the index into several categories by comparing their capitalization weight to a threshold level.
Similarly, U.S. Pat. No. 5,819,238 (the '238 patent) discloses a method for automatically modifying a financial portfolio having a pre-defined universe of securities, such as an index fund that tracks a given capitalization weighted index, through dynamic re-weighting of a position held in each such security. Specifically, in the disclosed computer system, a target weight is associated with each such security relative to others in the same portfolio in proportion to a non-constant function of current capitalization weights of the securities in the index. Once these target weights are determined, then, in response to both the target weight of each such security and an actual weight, as a proportion of the portfolio in which that security was held, a trade will be generated by the system in order to conform, within a predefined band, the actual weight to the target weight so as to rebalance the holdings in the portfolio.
For indices reflecting international securities markets, relative weights may be calculated based on countries' relative GDPs or imports.
Indices are currently used in the industry as benchmarks allowing investors and portfolio managers to compare performance of one sector of the securities market to others. Indices are often used in order to create index funds, i.e., funds that purchase securities that mimic or represent a specific index, for example the Vanguard 500 Index Fund mimics the composition and, supposedly, performance of the S & P 500 stock index.
Mortgage-Backed Securities are securities backed by mortgage loans, including pass-through securities, modified pass-through securities, mortgage-backed bonds, and mortgage pay-through securities. MBS are created when mortgage loans are pooled and underwritten by eligible issuers. Conmmonly referred to as “pass-through” certificates, these MBS entitle an investor to an undivided interest in the underlying mortgage loan pool. Thus, an investor receives a pro rata share of the interest (net of servicing and guaranty fees) and/or principal on the underlying mortgage loans.
Several financial institutions have developed indexes for measuring changes in the MBS markets. For example, Lehman Brothers has developed an MBS Index (hereinafter “LB MBS Index”) which covers the mortgage-backed pass-through securities of GNMA (also known as “Ginnie Mae”), FNMA (also known as “Fannie Mae”), and FHIMC (also known as “Freddie Mac”). It is formed by grouping the universe of over 600,000 individual fixed rate MBS pools into approximately 3,500 generic aggregates. The aggregates included are priced daily using a matrix pricing routine based on trade price quotations by agency, program, coupon, and degree of seasoning. Lehman Brothers also developed a Mortgage-Backed Securities Index which is an unmanaged version of the LB MBS index and is composed of all fixed securities mortgage pools by GNMA, FNMA and the FHLMC, including GNMA Graduated Payment Mortgages.
In order to generate one of the LB MBS indices, a user must first select a set of securities that satisfy a number of subjective rules (for example, the total outstanding balance of each generic security must be at least $100 million), then price each issue within the index based on the provided “matrix pricing,” calculate the returns of each individual security within the index and calculate the index return as a market-weighted average of individual security returns. The weights of individual securities are subjectively assigned and are not related to the proportion of the total outstanding principal on a particular security and total outstanding principal for the selected pool. Additionally, as explained further below, mortgage-backed securities are traded in “to-be-announced” (TBA) transactions where the purchase price is settled at some future TBA date. In order to calculate an index's total return, TBA settle prices for each security have to be converted into same-day-settle prices. According to the LB MBS Index's published algorithm, this process involves complicated calculations which include adjustments for an unknown future cash flow.